Overview
Subpart 49.2 establishes the guiding principles for compensating contractors when a fixed-price contract is terminated for the Government’s convenience (T4C). The primary objective is to reach a fair settlement through negotiation and "business judgment" that compensates the contractor for work performed and preparations made, while specifically excluding anticipatory profits and consequential damages.
Key Rules
- Fair Compensation: Settlements are not strictly bound by accounting principles; they are a matter of judgment aimed at fair compensation for work done, including a reasonable allowance for profit.
- Profit Constraints:
- Profit is allowed on preparations and work performed but prohibited on settlement expenses.
- Anticipatory profits (what the contractor would have made on the unfinished work) are strictly disallowed.
- Profit is not allowed on materials or services not yet delivered by subcontractors at the time of termination.
- Adjustment for Loss: If it appears the contractor would have incurred a loss had the entire contract been completed, no profit is allowed. Instead, the settlement is reduced using a "loss ratio" formula.
- Settlement Bases:
- Inventory Basis: The preferred method; itemizes costs (materials, labor, etc.) allocable to the terminated portion.
- Total Cost Basis: Used only when the inventory basis is impractical (e.g., if production hasn't started or accounting systems are limited), requiring prior TCO approval.
- Deadlines: Contractors must submit a final settlement proposal within one year of the termination date and inventory disposal schedules within 120 days.
- Total Cap: The settlement amount (excluding settlement expenses) cannot exceed the total contract price minus any payments already made.
Responsibilities
- Termination Contracting Officer (TCO):
- Exercises "business judgment" to negotiate settlements.
- Determines the appropriate profit rate based on factors like contractor efficiency and risk.
- Inspects and accepts completed end items.
- Ensures no "double-counting" occurs between the termination settlement and any equitable adjustments for the remaining work.
- Contractor:
- Submits settlement proposals (SF 1436, 1437, or 1438) in a timely manner.
- Submits inventory disposal schedules (SF 1428).
- Maintains adequate (but not necessarily "unduly elaborate") cost accounting data to support the claim.
- Negotiates settlements with its subcontractors.
- Contracting Officer (PCO):
- Typically retains responsibility for negotiating equitable adjustments for the continued portion of a contract after a partial termination.
Practical Implications
- Negotiation over Audit: Because the FAR prioritizes "business judgment" over "strict accounting principles," the T4C process is more of a commercial negotiation than a rigid financial audit. Contractors who can demonstrate high efficiency and risk-taking are often positioned to negotiate higher profit rates (up to what they would have earned on the full contract).
- "Eat the Loss": If a contractor is performing poorly or is over-budget at the time of termination, the "Adjustment for Loss" rule prevents the T4C from becoming a "bailout." The Government will apply a penalty ratio to the settlement to reflect the contractor's projected loss.
- Prompt Documentation: The 120-day window for inventory disposal and the one-year window for the settlement proposal are critical. Missing these deadlines without an extension can jeopardize the contractor’s right to recover costs.
- Partial Terminations: In a partial termination, the contractor should immediately look at how the reduction in scope affects the unit price of the remaining work (e.g., loss of economies of scale) and request an equitable adjustment under FAR 49.208.